Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 30 August 2015

Going backwards on fiscal rules

I was preoccupied when it first came out, but I wanted to note the excellent discussion by Jonathan Portes of the government’s new fiscal rules. It draws heavily on our joint paper on the same subject. (The published conference volume version is now available online for those with access: working paper version here.) Jonathan gives a typically measured analysis, and in my opinion the analysis is fully consistent with the sentiments expressed in the letter I discuss here.

Before some you say what’s new, note that in terms of the form of the rule, our paper and Jonathan’s discussion is rather supportive of the framework that Osborne introduced in 2010 as a way of conducting fiscal policy in normal times. Remember that this aimed to hit a rolling target for the cyclically adjusted current balance within five years. (The target happened to be zero, but there is no reason why the target could not be a number other than zero for the surplus or deficit.) The big problem was to apply this rule in a situation when interest rates were at their lower bound. That aside, the rule makes a lot of sense because it exerts some control while still allowing the deficit to be a shock absorber, which is what economic theory tells us it should be.

As Jonathan points out, and as I have discussed in earlier posts, Osborne’s new surplus rule goes backwards in two major ways. First, it is for the total deficit rather than the current balance, so it puts a squeeze on investment just at a time that investment should be high. (Aside to journalists: I cannot recall reading a single economist who disagrees that now is the time to increase public investment.) Second, even with the get-out clause on growth, the new rule is likely to make the deficit much less of a shock absorber, and so lead to unnecessary volatility in taxes or spending.

The question that naturally arises is how could a Chancellor replace his own (normal times) good rule with such a poor rule? A lot of the credit for the good rule should probably go to Rupert Harrison, and no doubt his background at the IFS probably helped here too. (Even more credit should be laid at his door for the establishment of the OBR.) Harrison has now left, but not before the surplus rule was proposed, so the puzzle still remains, particularly as Harrison must know that in economic terms his/Osborne’s original rule is clearly superior to the new one.

The simple answer is politics. All too often, Osborne’s budget decisions seemed to have been designed to embarrass the opposition (for which, I should add, the opposition have only themselves to blame). Short term political expediency once again triumphs over sensible long term economics. This is one reason we have independent central banks. It also seems to be another example of the failure of the knowledge transmission mechanism that I talked about here.

On this occasion I’m inclined to put some of the blame for this failure on academics. There is quite a bit of academic research which has relevance to fiscal rules, but few academics have tried to translate this into practical knowledge that governments can use. This in turn is because there is no incentive for them to do so: papers like Jonathan and mine are not the kind of thing that normally gets into the top journals. I have always thought that this is an obvious gap which fiscal councils like the OBR could fill, but at present the OBR has no remit to do so.     

8 comments:

  1. “papers like Jonathan and mine are not the kind of thing that normally gets into the top journals”. Does anyone actually pay any attention to those journals? Bill Mitchell gave up submitting anything to journals long ago. I never look at them. I look at blogs like this one and anything else that looks interesting.

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    1. That was not the point. Academics look at these journals in judging other academics, so there is no incentive FOR ACADEMICS to write this kind of analysis. Governments could give them that incentive, but that really needs to be done through some institution - like a fiscal council.

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  2. "The big problem was to apply this rule in a situation when interest rates were at their lower bound. "
    This is the new normal. I see no reason to raise them - keep them at zero forever.

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  3. Talking of politics, the 'sensible rule' was set up under the influence of the 'sensible party' in the Coalition. Without the moderating effect of the LibDems or of economist Vince Cable in Government you can now see what the modern Conservative Party is all about: not being sensible.

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  4. Instead of raising rates, increasing CAR (Capital requirements) could be used to reduce lending.

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  5. 'public investment'?
    How is that different from 'public spending'?

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  6. «The simple answer is politics. All too often, Osborne’s budget decisions seemed to have been designed to embarrass the opposition [ ... ] another example of the failure of the knowledge transmission mechanism that I talked about here. In this occasion I’m inclined to put some of the blame for this failure on academics.»

    Oh please, if the politics work, if the politics do embarrass the opposition, blame first and foremost the voters, if they fall for that kind of politics.

    For someone from the sacred warren of the central bank and the hallowed spires it must be natural to assume that the wise philosopher-kings like politicians and their advisers academics or not should be blamed if politics gets in the way.

    But in a democracy it is voters who should be accountable first and foremost for how they vote, and if their vote is susceptible to easy misdirection, too bad for them.

    Rather than trying to improve the level of awesomeness of the wise philosopher-kings, improving the learning and judgement of average voters is a much more robust if more time consuming route.

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  7. I'm here for calling it out on public spending and investment and how it all comes down to political semantics - cynical maybe.

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